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How Will Stolt-Nielsen, S.A. v. Animalfeeds Int’l Corp. Change Reinsurance Arbitration Practice?

June 1st, 2010 Arbitration Practice and Procedure, Authority of Arbitrators, Awards, Grounds for Vacatur, Labor Arbitration, United States Supreme Court Comments Off on How Will Stolt-Nielsen, S.A. v. Animalfeeds Int’l Corp. Change Reinsurance Arbitration Practice? By Philip J. Loree Jr.

Part II

A.   Introduction

In Part I (here) we explained why the standard for challenging an award based on its outcome is important in reinsurance arbitration practice.  And, after briefly reviewing pre-Stolt-Nielsen law on outcome-based standards of review, we explained how Stolt-Nielsen has established a fairly searching, standard of review.  This Part II explores the legal and practical implications of that standard of review.    

B.   Legal Implications of the Stolt-Nielsen Decision’s Manifest Disregard of the Agreement Standard of Review

1.  Courts May Interpret Stolt-Nielsen’s Outcome-Based Standard of Review Liberally

Reinsurance-  and other commercial-arbitration awards are now subject to the same standard of review as labor-law awards – and in Stolt-Nielsen, the Court applied that standard of review pretty liberally.  The Court has put to rest the notion that Federal Arbitration Act Section 10(a)(4) vacatur is limited to questions concerning whether the arbitrators decided a matter falling within the scope of the parties’ arbitration agreement or submission.   The outcome of the arbitration is now subject to at least some, limited scrutiny. 

The focus will now be on whether the arbitrators interpreted, applied and enforced the contract, and applied applicable law or norms.  Express or implied reliance on extra-contractual considerations, such as public policy, may spoil an award, unless those extra-contractual considerations are grounded in applicable law.  Not heeding clear and unambiguous contract language, effectively deleting or disregarding contractual provisions or otherwise rewriting the contract may also subject the award to vacatur. 

Interpreting a contract according to reinsurance custom and practice will remain permissible, because doing so is usually consistent with contract interpretation rules, and, in any event, reinsurance contracts are supposed to be interpreted in light of custom and practice.  An award that relies on custom and practice would presumably draw its essence from the reinsurance contract, provided that the interpretation has at least a barely colorable basis in the contract or applicable law. 

Honorable engagement clauses will continue to give arbitrators a degree of discretion to depart from the ordinary meaning of contract terms, and permit certain looser interpretations that are based on honorable engagement.  But, as we have pointed out in a prior post (here), in jurisdictions that have adopted outcome-based standards of review, interpreting an honorable engagement clause as a license to rewrite a contract would be tantamount to inviting a court to vacate the resulting award.  Now that Stolt-Nielsen has adopted a uniformly applicable, outcome-based  standard of review, that is now true in all jurisdictions. 

Labor-law precedent construing the “manifest disregard of the agreement” standard is now more relevant than before.  In jurisdictions that had not previously adopted the labor-law standard of review in the commercial context, such precedent was often distinguishable.   That is no longer necessarily the case, and labor-law precedent interpreting the standard will be at least persuasive authority for how the standard should be interpreted in the commercial context. 

The relevance of labor-law precedent cannot be discounted, for it confines the role of the arbitrator to the interpretation and application of the contract more strictly than does commercial-arbitration precedent.  In part that is because the Labor Management Relations Act says that “[f]inal adjustment by a method agreed upon by the parties is declared to be the desirable method for settlement of grievance disputes arising over the application or interpretation of an existing collective bargaining agreement.”  29 U.S.C. §173(d) (emphasis added); see, generally, Wright v. Universal Maritime Serv. Corp., 525 U.S. 70, 77-80 (1998).  While the Supreme Court had not previously suggested that the federal policy in favor of arbitration is limited to “disputes arising over the application or interpretation of” a commercial contract, the Supreme Court in Stolt-Nielsen nevertheless declared that: 

It is only when [an] arbitrator strays from interpretation and application of the agreement and effectively ‘dispense[s] his own brand of industrial justice’ that his decision may be unenforceable.  In that situation an arbitration decision may be vacated under § 10(a)(4) of the FAA on the ground that the arbitrator ‘exceeded [his] powers,’ for the task of an arbitrator is to interpret and enforce a contract, not to make public policy.

Stolt-Nielsen, Slip op. at 7 (emphasis added).   The language used by the Court strongly suggests that a commercial arbitrator’s powers are co-extensive with that of a labor arbitrator, no matter how broad the scope of the arbitration clause.    

But we believe that the standard will probably not be interpreted quite as strictly in the commercial context.  Commercial arbitration is not subject to the LMRA, and the policy considerations relevant to labor arbitration — including the need to maintain industrial peace, and to protect the rights of individuals arising out of a collective bargaining agreement that is negotiated and entered into by the union in a representative capacity only – do not apply in commercial arbitration. 

Interpreting Stolt-Nielsen too literally would lead to anomalous results.  For example in labor arbitration statutory claims are not presumed to be arbitrable because they concern the meaning of a federal statute, not the interpretation or application of the agreement.   See Wright, 525 U.S. at 78-79.  Courts therefore require clear and unmistakable of an intent to arbitrate statutory claims.  See 525 U.S. at 80-82.  But in commercial arbitration such claims are arbitrable provided the parties agree to a broad arbitration clause, because commercial contracts are usually negotiated and entered into in an individual or entity capacity, and the parties are thus able to directly protect their own interests in the bargaining process.  See, generally,  525 U.S. at 80-82.

So the upshot is that labor precedent will likely inform a court’s application of the standard in the commercial context, but that the courts will not blindly apply it when doing so would be inimical to the purposes of commercial arbitration as expressed by commercial-arbitration precedent, and would effectively import into commercial arbitration a special rule or standard that serves only policy considerations relevant to labor arbitration.  But based on the standard articulated in Stolt-Nielsen, and the way the Court applied the standard to the facts, the Court has effectively said that the decisions of commercial arbitrators have to be based on at least barely colorable interpretations of:  (a) the contract or (b) applicable law and norms.   

2.  The “Manifest Disregard of the Law” Standard May be Subsumed in Whole or in Part within the Court’s “Manifest Disregard of the Agreement” Standard

While the Court stopped short of deciding whether the “manifest disregard of the law” standard of review survived Hall Street Associates LLC. v. Mattel Inc., 552 U.S. 576 (2008), the Court’s dictum–and even its holding—strongly suggest that the standard is not only alive but thriving.  The Court criticized the arbitration panel for not “inquiring whether the FAA, maritime law, or New York law contains a ‘default rule’ under which an arbitration clause is construed as allowing class arbitration in the absence of express consent .  .  . ,” and instead applying its own public-policy-based rule derived from other arbitral decisions.

That alone may be read as an admonition to arbitrators to interpret and apply the law, not their own rules, but there is more.  While the Court recognized that it could have remanded the matter to the arbitrators under Federal Arbitration Act Section 10(b), it did not because it concluded that no outcome was permissible under the Federal Arbitration Act under the facts before it other than the one it set out to articulate later in the decision.  Stolt-Nielsen, slip op. at 12. 

The Court thus did not consider the arbitrators authorized to disregard — let alone manifestly disregard — what it considered to be the applicable rule under the Federal Arbitration Act.  Whether that means the Court has effectively endorsed vacatur for “disregard of the Federal Arbitration Act” only, or “manifest disregard” of any applicable law, is open to question. 

The opinion suggests that the court was effectively endorsing the broader, “manifest disregard of the law” standard.  The Court stated that the panel went astray when it disregarded whatever law there was on the applicable default rule when the parties’ contracts are silent on class arbitration, and instead based its decision on its own notions of public policy.  So however the Court might have characterized the standard of review, it appears to encompass at least some situations that might otherwise be characterized as “manifest disregard of the law.”  Indeed, the Court noted that vacatur would be required in Stolt-Nielsen had the Court decided to apply a “manifest disregard of the law” standard. 

3.  Stolt-Nielsen May be Construed as Making Certain Public-Policy-Related Matters Non-Arbitrable, Even Under a Broad Arbitration Clause

Stolt-Nielsen may be construed as rendering public policy-based issues nonarbitrable, even when the parties’ arbitration clause is arguably broad enough to encompass them.  Stolt-Nielsen said that the role of arbitrators was not to make public policy, but to interpret and apply the terms of the parties’ contract, and ruled that the arbitrators exceeded their powers by imposing class arbitration based on their own notions of public policy.  The Court pointed out that the arbitrators had effectively–and erroneously–assumed the role of a common-law court in ascertaining and applying what it perceived to be applicable public policy.

But it should follow that the arbitrators never had the authority in the first place to decide the question whether class arbitration should be imposed as a matter of public policy.  Suppose a party asks an arbitrator to determine whether a provision in a reinsurance contract violates state public policy, but there is no state law on the books articulating the applicable public policy or stating whether or not the public policy does or does not justify enforcing a contract provision identical (or at least similar) to the one the arbitrator has been asked to rule upon.  In that circumstance the arbitrator would have to:  (a) ascertain whether there was or was not a relevant policy; (b) determine what the policy was and whether the contract provision was inconsistent with it; and, if the policy was inconsistent with the contract provision, (c) determine whether the policy is sufficiently important that it should trump a countervailing state policy of enforcing contracts according to their terms. 

It seems to us that, after Stolt-Nielsen, the parties should not be required to submit the public-policy issue to arbitration under the circumstances in the hypothetical above, even if their arbitration agreement was broad enough to encompass the issue.  For the arbitrators would simply be making a public policy determination that the Supreme Court suggested must be made by a common-law court, at least in the absence of any clear statutory or case law guidance on which the arbitrator could base his or her decision.    

C.   Practical Implications of the Manifest Disregard of the Agreement Standard

The most obvious practical implication that the decision will likely have will be to increase the frequency of motions to vacate.    Stolt-Nielsen has certainly affirmed that Section 10(a)(4) can and should be construed broadly to encompass a challenge to an award’s outcome.  And it has resoundingly approved applying the labor-law based “manifest disregard of the contract” standard to commercial arbitration awards, and implied that the standard encompasses, for all practical purposes, the “manifest disregard of the law” standard.  With courts around the country now uniformly having greater discretion to review arbitration awards, lawyers and their parties will no doubt seek to reap the perceived benefits of that discretion and to test its scope.    

While we do not believe that the Supreme Court has opened the proverbial floodgates to outcome-based challenges of arbitration awards, we do think that more will be granted.  How many more remains to be seen, but it is safe to assume that final arbitration awards have probably become a tad less final. 

Reinsurance arbitrators will have to take careful note of Stolt-Nielsen’s standard of review.  To ensure finality, their awards will need to be grounded in the contract and governing law and norms.  While most good arbitrators generally render awards that are so grounded, Stolt-Nielsen appears to have upped the stakes a bit, slightly increasing the risk of vacatur.  Arbitrators need to be familiar with the Stolt-Nielsen standard of review to help mitigate the increased risk.  

Stolt-Nielsen’s heightened standard of review may be a welcome development to some parties.  There are those in the industry who have complained that reinsurance arbitrations have become too unpredictable, and there are some who complain that they have been on the losing end of what they consider to be arbitrary awards.  Some of these parties no longer agree to include arbitration clauses in their contracts. 

The heightened degree of judicial discretion that Stolt-Nielsen permits may allay some or all of these concerns.  And depending on how courts interpret Stolt-Nielsen, parties that no longer utilize arbitration clauses might eventually reconsider that strategy.    

But there are other parties whose principal concern about arbitration is its cost.  Stolt-Nielsen is likely to increase the frequency of motions to vacate, and more will probably be granted.  Obviously that will result in increased arbitration-related costs, and that may lead some of these parties not to include arbitration clauses in some or all of their new contracts.  Or those parties may seek alternative, and presumably less costly, ways of resolving disputes, such as mediation or negotiation. 

As we suggested in Part I, the choice of the standard of review involves a delicate balancing act between competing considerations.  It is unclear to us at this juncture whether the balance struck by Stolt-Nielsen will encourage or discourage arbitration of reinsurance disputes.  Arbitration may be a foregone conclusion as respects disputes on old business, but its continued use on new business will depend in part on how the courts interpret this new, uniformly applicable standard of review, and on whether the Supreme Court ultimately decides to change it.


Editor’s Note:  Here’s a list of links for Parts I through V of our Stolt-Nielsen reinsurance-arbitration series: 

Part I, Part II, Part III, Part IV, Part V.A, Part V. B, and Part V. C

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